A Genetic Algorithm for UPM/LPM Portfolios
AbstractSome researchers and many practitioners have move from the classic mean-variance (Markowitz, 1959) portfolio theory to a new portfolio optimization framework based on downside-risk measures that are more appropriate to the investorâ€™s preferences. Moreover, several studies (Friedman and Savage, 1952; Kahneman and Tversky, 1979) have point out the existence of S-shape utility functions in investors, which mean, investors are risk-averse and risk-seeking. In this paper we propose a new portfolio optimization framework based on minimizing the Lower-Partial-Moment (LPM) and maximizing the upper-partial-moment (UPM) returns that is more in accordance to the investorâ€™s behavior and the S-shape utility function found in real world. Given the complexity of the optimization problem, and the high nonlinearities and discontinuities, we use a metaheuristic (genetic algorithm) to achieve our goal. We find that, in general, the UPM-LPM portfolio optimization beats the classical mean-variance optimization and the mean-downside risk portfolios. Also, we find that the bigger differences happen close to the portfolio of minimum downside-risk and the smallest differences are in the area of the efficient frontier where the potential upside return is maximize.
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Bibliographic InfoPaper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 357.
Date of creation: 04 Jul 2006
Date of revision:
Downside-risk; Upper-Partial-Moment; Genetic Algorithm; Optimization;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
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